Diversified Investors, Don't Lose Your Balance

Stocks and Bonds Look Pricey, but Stay Allocated to Each

Investors with diversified mutual-fund portfolios would have been hard pressed to lose money in 2014's first half, but that doesn't mean it's time to go all-in on stocks or bonds.

Among about 100 mutual-fund categories tracked by investment researcher Morningstar, just seven lost value in the six months that ended June 30, and the losers were mainly volatile "trading-inverse" funds that use short selling and more complex tactics.

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Overall, the S&P 500 index rose 6.1% and the Dow Jones Industrial Average 1.5% in that time. Thursday's strong job numbers put the Dow over 17000 for the first time. It closed at 17068 in abbreviated preholiday trading.

As if to prove the difficulty of timing any market, even long-term U.S. Treasury bonds gained, despite all expectations to the contrary. Some two dozen long-term government-bond mutual funds tracked by Morningstar rose almost 13%, on average, in the year's first six months, after falling about that much in 2013. (The Morningstar data cover open-ended mutual funds and exclude exchange-traded funds.)

"Over the last six months, almost everything went up," says David Kelly, chief global strategist at J.P. Morgan Funds.

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Tim Foley

Here's what hasn't gone up: volatility. One measure of volatility, the VIX index (also called the "fear index," because it measures expectations for stock-market volatility in the month ahead) is near record lows.

The market's calm seas are overdue for inclement weather, some analysts say. The problem is that no one knows when, and investors who try to time the market often fail.

Joe Davis, chief economist at Vanguard Group, notes that riding the market's waves can prove valuable for those who can stomach it. "Trying to time any sort of spike in volatility is a) very difficult and b) it's precisely those spikes that ultimately lead down the road to higher returns," he says.

Plus, while stocks aren't cheap, investors don't have a lot of great alternatives.

"The stock market has about average valuations, relative to the last 25 years," Mr. Kelly says, but that's still "pretty attractive relative to the yields you get on most bonds or relative to the very low interest you would get on money sitting in a savings account."

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Mutual fund flip-flop

While most boats rose in the first half of the year, some mutual-fund categories saw a steep pullback from 2013 gains. Small-cap growth funds, for example, went from a 41% run-up, on average, in 2013 to a gain of less than 1% so far this year.

And some poor performers last year have enjoyed hefty gains this year. For example, real-estate funds are up almost 17% on average year-to-date versus a 2% gain last year, and precious-metal stock funds are up about 28% this year compared with a 49% drop last year.

That type of performance "makes the case for occasional rebalancing," says Russel Kinnel, director of manager research at Morningstar. "You're taking money out of the stuff that's done really well and putting it into the stuff that hasn't," he says. "That would have served you well at the end of last year."

It's not uncommon for a sector at the bottom in terms of performance one year to rise to the top the next, and vice versa, according to data on returns for 10 asset-class indexes, compiled by Nuveen Investments, a money management firm.

This year, equity mutual funds that focus on utilities, energy and health care are some exceptions to that flip-flop behavior, posting gains, on average, of about 17%, 16% and 11%, respectively, so far this year, on top of gains of 18%, 23% and 48% in 2013, according to Morningstar.

But be wary of short-term performance, Mr. Kinnel warns. "There is some randomness and unpredictability in single-year returns," he says. "It's interesting and informative to see what stories these categories have to tell, but the more important thing is to have a plan and stick to it."

Looking ahead

Long-term bonds' unexpectedly strong performance of late may have investors scratching their heads, after so many years hearing about the risk rising rates pose for bond portfolios. But that risk is still there.

Even so, says Vanguard's Mr. Davis, "Generally speaking, risk in fixed income pales in comparison to risk in equities."

In other words, you know the drill: Stick to a broadly diversified portfolio of stocks and bonds, and don't get too excited about either asset class.

"Investors are grappling with low stated yields on bond portfolios, but equity markets broadly speaking certainly aren't cheap by historical standards," Mr. Davis says. "Which risk is one more concerned about? Going through that calculus will lead one to certainly not take on very aggressive positions in either direction."

J.P. Morgan's Mr. Kelly predicts stronger economic growth in the second half, providing a tailwind for stocks. But he says the bond market might see higher interest rates. He says he is overweight equities relative to fixed income, but within equities favors a slight tilt to Europe and emerging markets. "I like U.S. equities," he says, but he sees less potential for growth going forward.

There's another risk for investors to consider. Liz Ann Sonders, chief investment strategist at Charles Schwab, says that fear of inflation, rather than inflation itself, poses a risk.

"An inflation scare is a risk for the second half that we believe is being overlooked," she wrote in a recent market commentary. "We are still in the camp that believes actual inflation won't be a problem, at least for the rest of this year, but concern among investors could cause some short-term bumpiness.

"U.S. economic data continues to improve and we believe stocks will move higher, but the risk of a pullback has risen," Ms. Sonders wrote. "It could be ignited by an inflation scare, which could also cause Treasury yields to rise relatively quickly, at least short-term."

To Barbara Lawson. If you buy strong dividend-paying stocks to get living and "walking around" $$$$s, you might be best off if you keep them, not sell them. I am not sure about this so don't act just according to what I say here....but I think (Repeat I think) all of your stocks automatically will be valued at their market price on the day that you die. That means that your stocks which would have large capital gains if you sold them while living will have no capital gains on the day you die. I think (hope) I got this right. Cheers! Ralph D.

Well...I'm glad I wasn't "off the wall" asking for a total of dividends from all of the 500 corporations in the 500 Index. I appreciate the helpful and thoughtful replies I got to my question. To repeat it while I'm "on the line".: Like the Big Board's index of the 500 stocks and like the plus or minus value this total index is posted daily, why can't there be, for the same 500 index...a total of all dividends they pay? I don't think it would change day-to-day enough to publish results daily, but probably quarterly after all quarterly dividends have been paid, and yearly. Such an index may not be of much value for 2014, 2015, 2016 and present early years but, if it had been published since before the 1929 crash, and during following significant market dips, it would, today, give investors who invest for dividends some idea of what to expect will happen to their dividend income in the coming big downturn so many are predicting. oOo

I am replying to your post to me which is about 3 posts down this string. I do not know how to reply directly to you. Sorry. (MORE)

I thank you for your response to me. I don't understand your view about profits.The basic reason a corporation is in business is to make money for its shareholders. I don't consider dividends as money not to give to shareholders. I consider such money paid to shareholders simply as distribution of profits made by a corporation. My experience has been that strong corporations have and use "other options" in addition to paying dividends. They use part of their profits to improve their structure with new factories, new equipment, new distribution methods...and so on. Then they also use part of their profits to reward the people who risked supporting that corporation by sharing some profits with dollars. I wonder what companies you like well enough to own shares in. Regards, Ralph D. oOo

Exactly half the market is selling today. WSJ wants to hide this, ... because near the peak of a bubble, it is usually the Banks who are dumping on naive Christians.

Banks bought stocks on the cheap during the crisis. They bought them from naive Christians with the money that Bernanke gave the Banks. Bernanke called it stimulation. Bernanke _only_ gave the money (or freshly printed inflation) to his Bankers.

Now the Bankers are selling it to naive Christians and making a killing. Yellen has given the word, she will soon stop stimulating. All this printing is causing inflation, so she will withdraw for a while. Markets will crash, Christians will panic, Yellen will stimulate again, Bankers will buy.

Bankers get richer. Naive Christians get more into debt. Bernanke/Yellen get some kickbacks later.

"...inflation scare..." Should owners of solidly strong dividend-paying stocks be scared of inflation? As I have posted before about utility stocks and companies that produce strongly branded and bought products will charge for their products in the future dollar of the day, profit in the future dollar of the day, pay dividends from profits in the future dollar of the day. I repeat that I believe inflation is driving the stock market up, confounding the analysts...because it's the best game in town for those who want to protect the value of their nest eggs for a long time. (MORE)

What did dividends from ordinarily strong corporations do in various market crashes and dips? It seems to me that somebody would have been keeping the dividend totals of the major 500 companies and have the yearly collective total stats so we can compare what dividends do in weak circumstances. If this is being done, I have missed seeing the results. oOo

For those with the foresight to have built a sizable IRA or 401(k), that's an easy place to go to avoid tax liability on transactions.

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Other than that, I've seen far more capital lost to market fluctuations than to taxes over the years by letting the tax tail wag the dog. The stock market has an uncanny ability to solve your tax problem for you.

@Ralph Dombrower Well if you look at a major funds website, like Vanguard, and to the price/performance of each fund, it shows you current yield. In the case of their S&P Index fund that yield is only dividends, shown in percentage terms. I assume its now around 2%. I would guess they have good historical data so if you could get the same for year end of past couple of years perhaps it would show the trend. Or am I missing what youre saying?

As for post-dip dividend issues, I guess on the one hand you have an increase in percentage terms due to lowering of the denominator/stock price, but on the other hand if the economy stinks you have a lowering of the numerator/earnings, which offsets, so perhaps no big change in percentage terms...though dividends go down in absolute terms.

I'm not a bank but have been selling recently along with establishing a fairly substantial short position.

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Gee, I'm not religious today but was raised in a Christian sect. I'd like to make sure I'm not selling to any Christians. Could you help me understand how I can do that?

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I would hate to tarred with the same brush as the banks because Dr. Bernanke never gave me any money. Of course, he didn't give any money to banks, either, except for 0.25% per annum but only on excess reserves. Of course, if a bank has excess reserves, it, by definition, has borrowed exactly $zero from the Fed, as well.

If you want income, loan your money out and collect the interest payments.

Why invest in a company whose internal return on equity is so paltry that they have no better options than to simply give the money away to shareholders? A company that says to me "here, we can't think of anything useful to do with this money" raises flags in my mind.

@Ralph Dombrower You have to check individual companies, but if you are talking about consumer staples a lot of them maintained or increased their dividends through the downturn, largely because their earnings were not impacted. I think P&G is the textbook example of this; they've paid a dividend for 123 years and have increased it in each of the past 57 years.

I agree it would be nice if data were easier to get (ycharts.com appears to have a tool). A lot of this can be done fairly simply on a Bloomberg terminal (well, as simply as anything can be done on a Bloomberg); I would love to see Google step-up its finance product offering to give the individual value/fundamental investor the same data analysis tools as a pro using a terminal.

Briefly, dividends were pretty stagnant during the great depression, ranging from $2 (1930) to $1.25 (1933 - 35). But an original share from 1927 would now be about 208 shares (because of splits), worth about $21,000, and paying some $506 in annual dividends. The last time this company (or its predecessor) actually cut the dividend was in 1948. So while dividends weren't perfectly secure during market downturns, the income stream has increased pretty steadily, at about 6.5% per annum (1927 - 2014). And the market price has gained about 6% per annum over the same period ... 12.5% compounded for 87 years is not too shabby.

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